Joeri de Wilde: Sluggish ECB slows down energy transition

January 16, 2024

^{This column was originally written in Dutch. This is an English translation.}

By Joeri de Wilde, Investment Strategist at Triodos Investment Management

The ECB does not appear to have any intention of lowering the policy rate any time soon. Yet she should do this if she takes her mandate seriously. Because an unnecessarily high interest rate not only has economic consequences, but also slows down the energy transition.

'Between hike and cut, there's a whole plateau, a whole beach of hold,' said ECB President Christine Lagarde, who indicated shortly after the policy meeting in December that there had been absolutely no discussion about interest rate cuts.

In doing so, she deviated from the much less cautious tone of Fed Chairman Jerome Powell. A day earlier, he indicated that the discussion about interest rate cuts had started and that interest rates had to be lowered before the 2% inflation target was reached.

Lagarde's reluctance is particularly striking in this light, because the situation in the eurozone is much more dire, both economically and geopolitically.

Dated wage figures and a recession

Lagarde's reluctance seems to stem from the fear that inflation in the euro zone will resurface. But she bases that scare on the wrong indicators. The latest inflation figures already point to a decline, with core inflation in the eurozone of 3.4% in December (compared to 3.9% in the US). Yet the ECB continues to focus mainly on wage developments, a notoriously lagging indicator.

The current wage increases are of course mainly a response to previous significant price increases. The figures that the ECB considers most important are only reported on a quarterly basis. These did indeed continue to rise, but according to more recent estimates, wage increases have since started to weaken.

Since there has been hardly any economic growth in the euro zone for a year, there is no reason to fear persistent inflation. Recent surveys even indicate that there was a recession in the second half of 2023. In addition, the prospects are not much better until at least the summer, mainly because government cuts in the euro zone have already started in 2023, while the economy of the US may continue to ride the tailwind of a significant fiscal stimulus from 2023 for a while.

Different ailment, different medicine

The ECB should also remember that the root cause of high inflation in the Eurozone was not identical to that in the US. In the eurozone, there was mainly imported inflation, due to higher gas prices as a result of energy dependence on Russia. In the US, inflation was much more of a domestic problem, due to the overheated economy. The US is self-sufficient in energy.

These different causes also require a different approach from central banks. According to an estimate by Allianz, the Federal Reserve has contributed about 45% to the decline in inflation, mainly by suppressing domestic demand and keeping inflation expectations in check. The remaining 55% decline was due to the recovery of global trade chains after the COVID lockdowns.

Because the eurozone economy has never really been overheated, the need for a long period of high interest rates is probably less great. The ECB could therefore loosen the monetary reins earlier.

In addition, the higher interest rates in the euro zone are causing excessive damage to the energy transition. Higher interest rates mainly slow down renewable energy projects, because these are often capital-intensive projects with high start-up costs that require many years before they become profitable.

ECB must fully focus on energy transition

An unnecessarily long period of high interest rates therefore goes against the ECB's mandate to support the EU's 'general economic policy'. The EU wants to quickly get rid of fossil fuels, not only for the climate, but also to become less dependent on foreign powers. A higher interest rate actually extends that dependence. And this in turn creates a persistent risk of sudden price increases, which is at odds with the ECB's mandate for price stability.

Based on its mandate, the ECB should therefore fully commit to a rapid energy transition. This requires a lower interest rate. Every month that the ECB waits longer to do this unnecessarily hurts the EU economy. And even if the ECB ultimately lowers interest rates, it may still take some time before the economy has recovered enough and investments get going again. The ECB is therefore committed to preventing this unnecessary delay.